What Caused The Financial Crisis?

It’s an article of faith among conservatives that the fundamental cause of the crisis was excess lending to poor people and minorities. It’s equally an article of faith among liberals that the lending had little if anything to do with the crisis. The conservative view faces 2 powerful counter-arguments: (1) after the year 2000, the real driver of subprime lending was the non-bank sector, not subject to the CRA; and (2) the subprime market was just too small to tank the US financial sector. Sub-prime lending only became a threat when sub-prime loans were packaged into derivatives. The CRA did not require anyone to do that.

But the liberal view also faces a counter-argument: Sub-prime loans were the stuff of which the toxic derivatives were made, and it was not some idle whim or fancy of the bankers that led to the proliferation of sub-prime loans. For example, it was the pressure of the CRA that led to the invention of the concept of the “credit score” so as to diminish the discretion of lending institutions. Credit scores in turn became a driver of the expansion of credit to ever less creditworthy borrowers.

There is a sound critique of CRA, Fannie Mae, and Freddie Mac. But the notion that the financial crisis was mostly due to government forcing banks to offer loans to poor minorities is insulting and absurd. Without getting into a long complicated post, numerous companies made many billions of dollars off the US mortgage industry. We're supposed to believe they would've passed on that opportunity absent federal pressure? If politicos want to get government out of the housing business they should take a look at the mortgage interest deducation, the perverse incentives of which continue to this day.

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